Should You Buy PayPal or This European Payment Company?

Payment processing is a lucrative business. By skimming a little off the top of each payment, companies in this field provide themselves with a nearly never-ending revenue stream, making them potentially fantastic investments.

PayPal (PYPL 1.96%) was one of the first digital payment processors and has risen to become the go-to system for many consumers. However, the business and stock have both fallen on hard times after having multiple great years. Investors may wonder if PayPal is still a good investment in the payments space and if there are better ones out there. One name that pops up as a potentially better investment is Adyen (ADYEN 0.89%).

While these two don't operate in the same payment processing segment, they're both in the industry. So let's find out if investors should stick with PayPal, or if Adyen is a better pick.

The businesses

PayPal's business is self-explanatory: Consumers can use various payment methods from within their PayPal accounts and use PayPal to make purchases or send money to friends. Essentially, it's a middleman between a customer and a business.

Adyen is similar, except it's a middleman businesses use. Adyen gives businesses the power to process various forms of payment on one platform, whether in the store or online. In addition, because it's on one platform, Adyen can help its clients better understand their customer base. Furthermore, it is able to process various forms of payment, including those found in less developed countries.

Because PayPal is consumer-facing, it has to serve millions of customers. On the other hand, Adyen is focused on businesses, and these clients usually make long-term commitments to a payment processor. Overall, this makes Adyen a more consistent company, as it is better insulated from consumer behavior.

This shielding was apparent in the second quarter, when PayPal's active accounts growth slowed to 6%, a multiyear low. As a side effect, revenue grew only 9% year over year (YOY) to $6.8 billion, and total payment volume (TPV) increased 9% to $340 billion.

Adyen had a more successful first half of 2022 (the Netherlands requires reporting only each half of the year rather than each quarter), as revenue rose 37% from a year ago to 609 million euros ($589 million) and processed volume increased 60% YOY to 346 billion euros ($335 billion). If we add PayPal's Q1 numbers, we can better understand how these two businesses compare. And we get a surprising result.

Sources: PayPal and Adyen.

Adyen's transaction margin is much lower. This is deliberate, as businesses have long complained about how much money payment processors take from a transaction. While Adyen's approach is a step in the right direction, investors should note that businesses still have to pay fees to other entities like credit card companies. PayPal's margin is much higher because it charges credit card–like fees when consumers send money.

With all the caveats in this analysis, it probably isn't a fair head-to-head comparison. Still, investors need to understand this difference before they write Adyen's business off as less profitable.

Because Adyen is just as profitable as PayPal, although that hasn't been the case historically.

ADYEY Profit Margin data by YCharts

This chart illustrates the steadiness of Adyen and the volatile nature of PayPal. Even though PayPal's profits could sometimes be higher, Adyen's steady profit nature makes the business easier to run, as it can forecast expenses better, which makes it easier to manage.

Adyen's advantages in dealing with businesses rather than consumers are apparent, but how is the stock valued?

Which stock is a better value?

PayPal's earnings have suffered from its recent difficulties. Therefore, comparing price-to-earnings ratios isn't fair. Plus, Adyen hasn't yet optimized for profits. A better measure for both these companies is free cash flow (FCF), which is an alternative means of gauging a business's profits through the lens of cash in and cash out. From this perspective, Adyen is cheaper than PayPal.

PYPL Price to Free Cash Flow data by YCharts

Fifteen times free cash flow isn't a bad price for any business, let alone one expanding like Adyen. For comparison, credit card issuers Visa and Mastercard trade at 24.2 and 31.7 times FCF, respectively.

With Adyen's steady profitability, rapid growth, and cheaper valuation, you'd have difficulty convincing me that PayPal is the better buy. One closing note before you load up your brokerage with Adyen shares -- it's a foreign stock. Now, there's nothing inherently wrong with this, but Adyen won't get the recognition or media coverage that domestic companies do. It could also be dragged down by a weak European economy, even though its business is global. These are just items to keep in mind before you take a stake in Adyen, but overall, the benefits far outweigh the downside.